Rumors of the coming “Slam Dunk” economic stimulus

Summary: Having missed the last opportunity for legislation to avert the possible double-dip in late 2010 or early 2011, rumors fly that Team Obama plans a massive unconventional stimulus. I suspect these rumors represent the flotsam and jetsam from serious discussions held in secret.

After the global economy crashed in late 2008, mainstream economists (e.g., Krugman, Delong, Romer) recommended a large fiscal stimulus. Some (e.g., Krugman) said that Obama would get only one chance. The resulting legislation fell short of that required to stabilize a decline in many ways like or worse than 1029-30. Now that stimulus is fading, the US economy visibly slows, and fears of another downturn steadily grow.

The Republicans having decided that “the worse, the better”, nothing can go through Congress without stronger leadership than the Democrats have at present. What else might Obama and Company do? Two articles suggest a possible plan of action.

US government-controlled entities lend, buy, or guarantee roughly 90% of new mortgages made in America today. The Obama administraion can use this apparatus to lower the rates on many existing mortgages, or even lower their outstanding value. Either or both would benefit not only those debtors, but by increasing their spending it would stimulate the economy. Without the approval of Congress. This would be daft, on many levels. First, as explained at Calculated Risk by Tom Lawler (economist and housing expert), it probably would not work.

The second flaw is more complex. Keynes and the economists who followed him showed that any fiscal stimulus boosts the economy (while it lasts). Pyramid-building, earthquakes, wars, burying bottles with banknotes for people to dig up, dropping money from helicopters, giving money to politically powerful special interest groups — they all work to some degree. (for more about fiscal stimulus see here and here) They differ from sensible plans in three respects.

social equity — rewarding politically powerful groups or random winners diminishes the social cohesion necessary for the nation to respond to the many stresses created by a long downturn.

long-term efficiency — We need not waste the money; the stimulus can be used to improve our long-term standard of living.

treatment of the problems that cause the downturn.

The cash for clunkers and cash for appliances plans act as government-funded lotteries, violating requirements one and two.

Number 3 points to the saddest aspect of this downturn. After three years neither the public nor many of our leaders see the driver of the housing crisis: we built too many homes. In some places they built far in excess of any real demand (e.g., Las Vegas, California’s central valley). Outmigration from mismanaged and dying urban areas (e.g., Detroit) caused more over-capacity. Supercharging the bubble was the purchase of homes by people who could not afford the prices paid. But overcapacity was the primary driver. Since America was born as a real estate speculation, with real estate fortunes one of its greatest wealth-generators, we see homes as an inherent good. Not as it is: a capital asset that can be unprofitable.

There is no fast or easy solution to overcapacity. There are possible tools to easy the painful transition, such as some version of FDR’s Home Owners Loan Corporation (HOLC; see Wikipedia). But we cannot treat a problem we do not see. Probably time and adversity will bring to us their special form of clarity.

Pray that we do not get another downturn. The fear and folly of our leaders — and of us — suggest that the resulting decisions will be ugly.